What is Financial

Management?

Concerns the acquisition,

financing, and
management of assets
with some overall goal in
mind.
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 Investment Decisions
Most important of the three
decisions.
What is the optimal firm size?
What specific assets should be
acquired?
What assets (if any) should be
reduced or eliminated?
1-2
 Financing Decisions
Determine how the assets (LHS of
balance sheet) will be financed (RHS
of balance sheet).
What is the best type of financing?

What is the best financing mix?

What is the best dividend policy?
How will the funds be physically
1-3 acquired?
 Asset Management
Decisions
How do we manage existing assets
efficiently?
Financial Manager has varying degrees
of operating responsibility over assets.
Greater emphasis on current asset
management than fixed asset
management.
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 What is the Goal
of the Firm?

Maximization of
Shareholder Wealth!

Value creation occurs when

we maximize the share price
for current shareholders.
1-5
 Shortcomings of
Alternative Perspectives
Profit Maximization
Maximizing a firms earnings after taxes.
Problems
Could increase current profits while
harming firm (e.g., defer maintenance,
issue common stock to buy T-bills, etc.).
Ignores changes in the risk level of the
firm.
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 Shortcomings of
Alternative Perspectives
Earnings per Share Maximization
Maximizingearnings after taxes divided
by shares outstanding.
Problems
Does not specify timing or duration of
expected returns.
Ignores changes in the risk level of the firm.
Calls for a zero payout dividend policy.
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 Strengths of Shareholder
Wealth Maximization
Takes account of: current and future
profits and EPS;
EPS the timing,
duration, and risk of profits and EPS;
EPS
dividend policy;
policy and all other
relevant factors.
Thus, share price serves as a
barometer for business performance.
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 The Modern Corporation

Modern Corporation

Shareholders Management

There exists a SEPARATION

between owners and managers.
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 Role of Management
Management acts as an agent
for the owners (shareholders)
of the firm.
An agent is an individual
authorized by another person,
called the principal, to act in the
latters behalf.
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 Agency Theory

Jensen and Meckling developed

a theory of the firm based on
agency theory.
theory
Agency Theory is a branch of
economics relating to the
behavior of principals and their
agents.
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 Agency Theory

Principalsmust provide incentives

so that management acts in the
principals best interests and then
monitor results.
Incentivesinclude stock options,
perquisites, and bonuses.
bonuses

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 Social Responsibility
Wealth maximization does not
preclude the firm from being socially
responsible.
responsible
Assume we view the firm as producing
both private and social goods.
Then shareholder wealth maximization
remains the appropriate goal in
governing the firm.
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